I had my foot on the gas as I left the road and blew out my mind
Eight miles outta Memphis and I got no spare
Eight miles straight up downtown somewhere
I just dropped in to see what condition my condition was in
I said I just dropped in to see what condition my condition was in
Yeah yeah oh-yeah
"Just Dropped In (To See What Condition My Condition Was In)" by Kenny Rogers and The First Edition
Watch it on YouTube:
Risk Diversification versus Asset Diversification:
After 2008 and early 2009's sickening plunge, when all assets seemed to plummet in synch, many investors felt betrayed by their advisors or the numerous talking heads that espoused the benefits of "Asset Diversification" in constructing an investment portfolio. They were told that asset diversification would protect them when markets fell, and when that didn't work the same talking heads told them that all assets are correlated during a panic. Who can blame them for being so confused "I tripped on a cloud and fell-a eight miles high, I tore my mind on a jagged sky". The problem wasn't diversification, the problem was they (or their advisors) confused "asset diversification" for "risk diversification". Most investors thought they were diversified because they owned ; large-cap stocks, mid-cap stocks, small-cap stocks, growth, value, core, international stocks, emerging market stocks, U.S. Government bonds, corporate bonds (investment grade and junk), international bonds, etc, etc. What many were doing was buying what Wall Street was selling...investment products...not diversifying.
While what I do is called "global tactical asset allocation", it is more about "Diversifying Risk" instead of "Diversifying Assets". Investors need to build diversified portfolios that truly diversify risk, not just assets. In the good old days we thought of asset allocation revolving around three main asset classes: stocks, for long-term growth; bonds, for income and safety; and cash, for liquidity. Many advisors would then allocate among these assets based on an investment time horizon; the longer the time horizon the larger the equity component of the portfolio, while the shorter the time horizon the larger the bond portfolio. What we really need to focus on is risk not product.
All investors are faced with a multitude of risks, and while risks can be scary, they can also be managed through proper active diversification.
What are some of the risks we should be cognizant of? And how do we invest for proper risk diversification?
Risks:
Inflation, deflation, currency devaluation, sovereign defaults, corporate defaults.
Diversifying Assets:
Inflation hedges- inflation linked bonds (TIPS), commodities, real estate, and equities, especially those linked to commodities.
Deflation hedges- U.S. Treasury bonds, which served as a safe haven in this most recent crisis even though this crisis was "made in the USA". But the next crisis may not be so kind to U.S. debt so we should also own some international sovereign debt.
Currency devaluation hedges- Gold, international currencies, and non-U.S. equities and debt.
Sovereign default hedges- Gold, and fiscally strong international markets.
Corporate default hedges- Very diverse global equity and fixed income portfolios that mitigate company specific risk.
While all these risks are with us on a daily basis, their probability of occurring in the near future is constantly changing, thats why active tactical asset allocation is paramount. My job as portfolio manager (or more appropriately risk manager) is to constantly ask, "what condition my condition is in"?
Investment Consideration:
Recently, as more of our equity, commodity, and fixed income holdings moved from bullish to neutral, cash as a percent of our holdings has been growing, and so has my discomfort. Generally cash (money market equivalents) is a pretty safe place to hang out, and that is still most likely the case, but I worry that maybe, just maybe, the currency (U.S. dollar) that our cash equivalents are denominated in may not be the safest. Is there a way to safely diversify the currency risk of our cash holdings? I think so.
The Chinese Yuan. China has just displaced Germany as the world's largest exporter with $1.2 trillion of goods shipped in 2009. The U.S. has not held the top spot since 2003. In 1980 China began a series of large currency devaluations that took the Yuan from 1.50 to the dollar to its current 0.15 cents, a devaluation of 90%. The goal was to make exports more competitive and they've succeeded beyond their wildest dreams. For over a decade China has been under pressure from global trade partners (especially the U.S.) to allow its currency to appreciate so foreign goods would be more attractive to the booming Chinese middle-class. China did allow its currency to appreciate 21% from July 2005 - July 2008, but has held it nearly steady at about 6.83 Yuan per dollar since then to help sustain their exports. On a purchasing power parity basis the Chinese Yuan is about 45% undervalued! The pressure is on. An artificially low exchange rate leads to an exploding inflation rate and potential trade sanctions. Congress and President Obama have been turning up the heat, and the Treasury Department may label China a "currency manipulator", which would allow Congress to impose punitive trade sanctions. On the other hand, China hates to be told how to do anything. The Chinese Central Bank governor, Zhou Xiaochuan, says he won't entertain a revaluation for the foreseeable future. The Americans say they want it last year. To me, that means sometime in the next year. When the Chinese allow their currency to appreciate, I don't expect it to be anywhere near 45%, but a gradual appreciation of maybe 5% a year would be acceptable.
Back to our problem, too much cash denominated in U.S. dollars.
A prudent way to diversify U.S. dollar risk would be to buy the Chinese Yuan. Since the Yuan is currently pegged to the dollar your downside risk is the same as holding the dollar, but if the Chinese again allow their currency to appreciate you will participate in that revaluation.
This is something easily accomplished for our clients through the use of...
Be careful out there,
Chris Wiles
This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management. The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
No comments:
Post a Comment